Information Technology and Productivityin the “New Economy”

Kevin J. Stiroh*

Federal Reserve Bank of New York

Digital Transformations in the Information Society

International Telecommunication Union & London Business School

June 1, 2006

*The views expressed here represent those of the author only and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System.

Outline

• The “new economy”

• IT and productivity growth

• Five questions

The “New Economy”

What is the New Economy?(circa March 2000)

• New economy forces– Information technology (IT)– Globalization– Deregulation

• New economy evidence– Faster productivity growth (output/hour)– Low unemployment and low inflation– Strong stock market

What’s Left of the New Economy?(circa June 2006)

• Some parts faded– Unemployment jumped to 6% in 2002– Stock market, particularly tech, down since 2000

• Some parts remain robust– Moderate inflation– Strong productivity growth (output/hour)

Focus on productivity growth and IT

Why Is Labor Productivity Growth Important?

• Productivity determines living standards

• Productivity helps offset inflationary pressures

Three Productivity Eras

-3

-1

1

3

5

7

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003

-3

-1

1

3

5

7

4-quarter growth in nonfarm business labor productivity.Dotted line represents averages for 1947:Q4-1973:Q4, 1973:Q4-1995:Q4 and 1995:Q4-2006:Q1. BLS (5/23/06).

PercentPercent

47:Q4-73:Q4 = 2.6% 73:Q4-95:Q4 = 1.5% 95:Q4-06:Q1 = 2.9%

Why is IT Important?

• Enormous technological progress– Moore’s Law– Price of a calculation fell by a factor of 1.2 trillion since

1900 (Nordhaus, 2001)– Rapidly falling prices

Overall Price Level has Risen...

0

20

40

60

80

100

120

140

1959q1 1964q1 1969q1 1974q1 1979q1 1984q1 1989q1 1994q1 1999q1 2004q1

GDP Prices

GDP price index, BEA (5/23/06).

…While Computer Prices Fell

1

10

100

1,000

10,000

100,000

1,000,000

1959q1 1964q1 1969q1 1974q1 1979q1 1984q1 1989q1 1994q1 1999q1 2004q1

GDP Prices

Computer PricesComputer Prices = -18.9%GDP Prices = +3.6%

GDP price index and computer price index, BEA (5/23/06).

Why is IT Important?

• Enormous technological progress– Moore’s Law– Price of a calculation fell by a factor of 1.2 trillion since

1900 (Nordhaus, 2001)– Rapidly falling prices

• Massive investment by U.S. firms– Nearly 40% of nonresidential business investment in IT– Real IT investment grew 16% per year since 1959

IT Share of GDP is Rising

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1959q1 1964q1 1969q1 1974q1 1979q1 1984q1 1989q1 1994q1 1999q1 2004q1

Per

cent

IT investment as a share of GDP. Current dollars, BEA (5/23/06).

IT and Productivity Growth

Three Sources of Productivity

• Capital deepening– Investment provides more/better capital to labor

• Labor quality– Compositional changes in the workforce

• Total factor productivity (TFP)– Technology and everything else

IT and Productivity:The Story

• Fundamental technological progress– Moore’s Law– Productivity gains in IT-production (TFP)

• Enormous declines in IT prices and increases in IT quality

• Investment in IT– Firms substitute toward IT– Productivity gains in IT-use (capital deepening)

IT and Productivity:The Evidence

• Sources of U.S. productivity growth resurgence

• IT / productivity link across industries and countries

• Case studies of individual industries

IT Drives the U.S. Productivity Resurgence1995-2004 less 1973-1995

Other TFP 0.6

IT-Use (Capital Deepening) 0.5

Other Capital Deepening 0.3

Labor Quality - 0.1

IT- Production (TFP) 0.3

ChangeIncrease inLabor Productivity Growth

Average annual contribution in percentage points for U.S. business sector.Jorgenson, Ho, and Stiroh (2006).

1.5

What Does the Industry Data Say?

• Examine link between IT and industry productivity

• Compare three sets of industries– IT-producing– IT-using– Other

Compare Post-1995Productivity Gains

0

4

8

12

IT-Producing IT-Using Other

Pro

duct

ivity

Gro

wth

(%

)

1988-1995 1995-2000Average annual percentages. IT-using have 1995 IT capital shares above the median.Stiroh (2006) based on GPO data released in December 2005.

Productivity Gains through 2000 Concentrated in IT Industries ...

5.2

7.6

0

4

8

12

IT-Producing IT-Using Other

Pro

duct

ivity

Gro

wth

(%

)

1988-1995 1995-2000Average annual percentages. IT-using have 1995 IT capital shares above the median.Stiroh (2006) based on GPO data released in December 2005.

Productivity Gains through 2000 Concentrated in IT Industries ...

5.2

1.3

7.6

2.2

0

4

8

12

IT-Producing IT-Using Other

Pro

duct

ivity

Gro

wth

(%

)

1988-1995 1995-2000Average annual percentages. IT-using have 1995 IT capital shares above the median.Stiroh (2006) based on GPO data released in December 2005.

Productivity Gains through 2000 Concentrated in IT Industries ...

5.2

1.3 1.7

7.6

2.21.1

0

4

8

12

IT-Producing IT-Using Other

Pro

duct

ivity

Gro

wth

(%

)

1988-1995 1995-2000Average annual percentages. IT-using have 1995 IT capital shares above the median.Stiroh (2006) based on GPO data released in December 2005.

…but Broader since 2000

5.2

1.3 1.7

7.6

2.21.1

10.6

3.1

1.9

0

4

8

12

IT-Producing IT-Using Other

Pro

duct

ivity

Gro

wth

(%

)

1988-1995 1995-2000 2000-2004Average annual percentages. IT-using have 1995 IT capital shares above the median.Stiroh (2006) based on GPO data released in December 2005.

International Comparisons

• Compare U.S. to Europe

1.2

2.3

2.8

2.3

1.8

1.1

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1987-1995 1995-2000 2000-2004

Pe

rce

nt

U.S. EU-15

U.S. Productivity Accelerates, while EU Productivity Slows

Note: Productivity is defined as GDP per hour worked. All figures are average annual percent growth. van Ark and Inklaar (2005).

Explaining the U.S. / Europe Divergencevan Ark and co-authors

• Both have strong productivity in IT-production, but Europe has smaller share

• Smaller gains in IT-using industries– Particularly Retail, Wholesale, and Finance– Labor and product market rigidities

• Faster growth in “New Europe” than in “Old Europe”

Case Studies• Trucking Industry

– Electronic vehicle management systems and GPS– More efficient operations, monitoring, fewer empty backhauls, less

waiting to load/unload

• Emergency vehicles– Computerized “enhanced 911” system leads to better matching of

equipment– Improved health outcomes and lower patient costs

• Retail – Technology allows scale and scope– Better information on customers, inventories, supply chain management

Productivity Outlook

• Project productivity growth for next decade

• Uncertainty about technological progress– Pessimistic– Base-case– Optimistic

• Range of technology forecasts– International Technology Roadmap for Semiconductors

Range of Productivity Projections

3.02.6

3.2

1.4

0.0

1.0

2.0

3.0

4.0

5.0

1995-2004 Pessimistic Base-Case Optimistic

Average annual growth rate for U.S. private sector.Jorgenson, Ho, and Stiroh (2006).

Percent

Range of Output Projections

3.02.6

3.2

1.0

0.7

0.7

1.4

0.7

0.0

1.0

2.0

3.0

4.0

5.0

1995-2004 Pessimistic Base-Case Optimistic

0.0

1.0

2.0

3.0

4.0

5.0

Labor Productivity Hours

Average annual growth rate for U.S. private sector. Numbers do not sum due to rounding.Jorgenson, Ho, and Stiroh (2006).

3.9

2.0

3.2

3.8

Percent Percent

IT and Productivity

• IT is important for productivity– Production and use both matter– Wide range of evidence

• Expect strong productivity for next decade– Considerable uncertainty, but little evidence of return

to slow pace of 1973-95

Five Questions

What Changed in 1995?

• Acceleration of IT technological progress– Shift to 2-year semiconductor cycle (Jorgenson, 2001)

• Widespread use of Internet and e-commerce– OECD (2000) and Nordhaus (2000)

• Emergence of open-source software– (DeLong, 2000)

• Learning-by-doing

Can IT Technological Progress Continue?

• Pessimistic view– Diminishing returns (Gordon, 2000)– End of Moore’s Law (Mann, 2000)

• Optimistic view– Silicon pipeline is full for the next decade or two– New technologies

• DWDM, blue lasers, molecular-scale electronics, nano and quantum computing

• Hard to predict long-run technological advances

Will Firms Continue to Invest in IT?

• Possible impediments– Rising interest rates– National security– Decline in investment funds due to current account– Saturation point for IT

• Reasons for optimism– Changes in “locus of innovation” and new applications– Relative price changes are driving investment

Does the “dot.com” Bubble Debunk the IT/Productivity Story?

• No – confusion of productivity and profits

• Ultimate winner will be consumers as profits are competed away and prices fall

Is IT the Whole Story?

• No

• Firms need complementary innovations– Human capital– Organization structure– Information flows– Workplace practices

• Weaker productivity/IT link since 2000– Intangible capital?

Conclusions

• IT has made important contributions to U.S. productivity gains

• Core of truth in the “new economy” hype– Technological progress lowers the price of IT– Lower prices spur IT investment

• Consensus that U.S. productivity growth will continue

Information Technology and Productivityin the “New Economy”

Kevin J. Stiroh*

Federal Reserve Bank of New York

Digital Transformations in the Information Society

International Telecommunication Union & London Business School

June 1, 2006

*The views expressed here represent those of the author only and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System.

Reference Charts

Decline in IT Prices Continues

-15

-10

-5

0

5

10

1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003

4-quarter growth in prices of computer, software, and communications equipment investment.BEA (5/23/06).

1959:Q1-2005:Q4 = -4.2%

Percent

IT Investment Slowed and Rebounded

-15

0

15

30

45

1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003

Computers, software, and communications equipment investment in chained 2000 dollars.Shaded areas are NBER recessions. BEA (5/23/06).

Percent

1959:Q1-2005:Q4 = 15.9%

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